Carbon leakage is a central concern in climate policy. When one jurisdiction introduces a carbon price while competing jurisdictions do not, regulated firms may reduce production while firms in unregulated regions expand. Emissions can therefore shift across borders rather than disappear, potentially undermining the effectiveness of unilateral climate policy.
My research examines whether this happens when two Canadian provinces introduced asymmetric carbon taxes before the introduction of the Canada-wide carbon tax in 2019.
Asymmetric Environmental Regulation, Interfuel Substitution and Carbon Leakage
Emmanuel Murray-Leclair
Journal of Environmental Economics and Management, Volume 136, 2026, Article 103263.
Carbon leakage occurs when environmental regulation reduces emissions in a regulated jurisdiction but causes production or emissions to increase elsewhere. For example, suppose a carbon tax raises the cost of producing a carbon-intensive product in one province. If competing plants in provinces without the carbon tax increase their production in response, part of the initial emissions reduction may simply be displaced geographically.
This possibility is an important argument in debates about unilateral carbon pricing and underlies policies such as carbon border adjustments that are now being implemented as part of the EU ETS.
However, production relocation is not the only way firms can respond to a carbon price. Plants may also switch fuels, alter their input mix, change their emissions intensity, or reallocate production among facilities with different technologies. Understanding these adjustment mechanisms is important for determining whether asymmetric carbon pricing actually produces carbon leakage.
I study plants' responses to carbon pricing using Canadian plant-level data and variation generated by the carbon taxes introduced in British Columbia and Quebec. British Columbia introduced its carbon tax in 2008, while Quebec introduced carbon pricing in 2007. Other Canadian provinces initially did not face equivalent carbon prices, creating variation in environmental regulation across regions.
I develop a production model with multiple fuel inputs, imperfect competition, and region-specific carbon taxes. Using publicly available plant-level data on air pollutants, I recover information about plants' fuel use from the chemical relationship between fuel combustion and emissions. This framework allows me to study how carbon pricing affects emissions, production, fuel choices, and the allocation of output across plants and provinces.
I find substantial emissions reductions in British Columbia, with the estimated 95% confidence interval ranging from 7% to 48%, and no reduction in Quebec. Despite the differences in environmental regulation across Canadian provinces, I find no statistically significant shift in production toward unregulated provinces.
In this setting, the evidence does not show the production relocation that would constitute the conventional carbon-leakage mechanism.
The results point to adjustment within the regulated market. Plants in British Columbia were able to respond to the carbon tax partly by switching from oil to natural gas. Production also shifted from relatively dirtier plants toward cleaner plants within British Columbia. These adjustments reduced emissions without requiring production to move substantially toward provinces without the carbon tax.
Carbon-leakage policy is often motivated by the possibility that unilateral carbon prices reduce the competitiveness of regulated producers and shift economic activity toward less-regulated jurisdictions. My results suggest that evaluating this risk requires understanding firms' technological flexibility.
Carbon leakage · Carbon pricing · Carbon tax · Environmental regulation · Interfuel substitution · Fuel switching · Firm dynamics · Industrial emissions · British Columbia carbon tax · Quebec carbon pricing · Environmental economics
Murray-Leclair, Emmanuel. 2026. “Asymmetric Environmental Regulation, Interfuel Substitution and Carbon Leakage.” Journal of Environmental Economics and Management 136, 103263.
DOI: 10.1016/j.jeem.2025.103263